Weekly view - A hazy picture

Last week, the Fed lowered the pace of its rate rises from 50 bps to 25 bps. In addition, in contrast with his comments after the previous rate hike, Fed chairman Jerome Powell suggested he was not unduly worried about the loosening of financial conditions—brought about in large part by a decline in energy prices and market expectations for Fed rate tightening. Instead, he said that the Fed’s focus “is not on short-term moves” and declared that “the disinflationary process has started. Markets rallied, choosing to ignore Powell’s dismissal of the idea of rate cuts and his reference to the continued tightness of the labour market. But then a much stronger-than-expected January nonfarm payrolls figure and a fall in unemployment to its lowest rate since 1969 sowed doubts in the minds of those optimistic about Fed policy, causing a sell-off in bonds and stocks on Friday. Meanwhile, US data last week were enough to cause whiplash: the robust employment report clashes with largescale layoffs by big tech firms; the ISM manufacturing index’s decline for the third consecutive month in January contrasts with the much bigger-than-expected rise in the ISM nonmanufacturing index last month. In short, labour-intensive service industries seem in robust health, whereas US factories, along with tech and communications-related companies, are having a harder time. Indeed, three big tech-related names produced disappointing Q4 earnings and pointed to slowing growth. All things considered, despite talk of a ‘soft landing’, we remain cautious on US equities. Valuations look aggressive considering the hazy economic picture, the Fed’s commitment to tough monetary policy and the chance of an earnings recession. 

Even though the ECB delivered a well-flagged 50bps rate hike on Thursday and committed to another 50bps move in March, it stated that the outlook for inflation and growth had become “more balanced” and that future decisions would be data dependent. Like Powell (and Bank of England governor Andrew Bailey), ECB president Christine Lagarde did not seem to push very hard against market pricing of an upcoming inflexion in monetary policy. The result was a rally in equities and bonds in Europe. Although some of this performance was reversed on Friday, the weekly gains sit somewhat uncomfortably with an economy that is skirting with stagnation amid weak household spending. Core consumer inflation rate in the euro area remained stubbornly high in January (5.2%) and the producer price index was above expectations. However, we recognise that equity valuations in Europe are lower than in the US. In China, the latest purchasing manager index figures point to an improvement in economic activity. China’s recovery should support energy prices in 2023 as China competes with Europe for relatively tight supplies. We will carefully monitor developments on this front, as well as upcoming inflation reports in Japan.